Creative Financing Strategy #2 - Subject To
This article is about purchasing an investment property “subject-to” an existing mortgage to leverage existing financing, thereby eliminating the need to apply for a new loan. Sounds great, right?
In a subject-to, the seller is willing to transfer title of their property to the buyer in exchange for the buyer promising to make the seller’s remaining loan payments.
The subject-to strategy is specifically beneficial for buyers who are new to real estate investing, wish to purchase the property with little cash or low, or both, or for those who need to buy/sell a property quickly and cost-effectively.
In a subject-to real estate transaction, closing costs include only the cost to record a deed. While recording fees vary depending on jurisdiction, the national average recording fee is $125, which compared to the national average closing costs of over $6,000, the low closing costs certainly make the deal more attractive for both parties.
Keep in mind, most loan documents have a “due on sale” clause which allows a lender to accelerate the due date of a loan in the event the borrower transfer’s the property’s title to someone else. However, a seller can bypass a due on sale clause in their loan documents under the Germain Act of 1982 if they transfer the property into their own land trust. What is this “trust” you speak of? I am glad you asked. You see, I like trusts. If you’re a real estate investor, you should, too.
A land trust is an agreement where a trustee holds ownership of the belongings of the trust for the benefit of a third party. For example, let’s say a seller and a buyer/investor want to use the subject-to strategy to transfer the property from the seller to the buyer, along with the mortgage seller has in the property. Also, assume the seller’s loan documents include a due on sale clause.
Thanks to the Garn-St. Germain Act of 1982, a seller and buyer/investor wishing to use the subject-to strategy would bypass the due on sale clause by completing the following respective steps:
create a trust;
if necessary, appoint the buyer as the trust’s trustee; and
list the seller as the trust’s beneficiary.
assign seller’s interest in the trust to the buyer/investor.
While this strategy does give rise to the due-on-sale clause, the assignment of interest from the seller to the buyer is a separate document that is not required by law to be recorded. If the lender sees that there was a transfer into a trust, they may ask for a copy of the trust for their files. You can mail the lender a copy of the land trust showing the seller as the beneficiary in compliance with the Garn-St. Germain Act.
Types of Subject-To
There are three types of subject to real estate deals: 1) cash-to-loan subject-to; 2) seller carry back subject-to; and 3) wrap-around subject-to.
A cash-to-loan subject-to is the most common and simple type of the subject-to family. When a seller and buyer enter into a cash-to-loan subject-to real estate transaction, the buyer will assume responsibility for the payment of seller’s existing loan balance, in cash.
For example, assume Buyer is purchasing a home for $500,000 from Seller. Also, assume Seller’s existing mortgage balance on the property is $450,000. In this situation, Buyer pays Seller $50,000 in cash in addition to the sales price. Here, Buyer does not assume the mortgage. Instead, Buyer is paying forward the extra sum of $50,0000 to Seller so Seller can pay off the remaining balance of the loan.
Seller Carry Back Subject-To
A seller carryback is also know as “seller financing” or “owner financing.” The transaction is similar to a second mortgage.
*For more information on this type of the subject-to family, check out our blog article Creative Financing Technique #1 - Seller Financing.
In a wrap-around subject-to real estate transaction, the seller of the property maintains the outstanding first mortgage which is then repaid in part by the buyer. Instead of applying for a conventional bank mortgage, the buyer signs a mortgage with the seller and the new loan is not used to pay off the seller’s existing loan.
For example, assume Seller has an $80,000 mortgage outstanding on its property with a fixed interest rate of 4%. Also, assume Seller agrees to sell the property to Buyer for $120,000. Buyer puts $10% down ($12,000) and borrows the remainder ($108,000) from Seller at a fixed interest rate of 7%.
In this situation, Seller will earn 7% on $28,000 (the difference between $108,000 and the $80,000 Seller owes on the original mortgage) plus 3% (7% - 4%) on the balance of $80,000 mortgage.